Evidence on sustainable investing

There used to be a difference between traditional investing and investing, which aligns with the investor's morals, so-called socially responsible investing. The view was that investors should be making as much money as possible using all the legal methods available. If the investor wants to participate in charity, then the investor can donate from the profits gained from investing. SRI-investing was seen as a wrong way to invest or even offensive to traditional SRI-investing, and the possibilities of corporate sustainability were not seen important. At least this was the case until the most socially responsible firms understood early that for SRI to gain recognition, their strategies needed to be evaluated against the conventional benchmarks for both risk and return.

From ignoring the importance of sustainability metrics, they are now seen as value-creating metrics. Several studies have been published on the impacts of sustainability on corporate financial performance. However, the results can be mixed. (Townsend, 2020, 11)

Nofsinger and Varma (2014) propose in their study that funds focusing on socially responsible attributes outperform traditional funds during market crises, and this is because of the socially responsible company's dampening downside risk. They argue that better ESG performance makes companies less risky, and they are more likely to manage crisis periods better. According to the study, the dampening downside risk comes at the cost of underperforming during non-crisis periods. For generating positive alphas during a market crisis, they suggest focusing on the desirable SRI attributes rather than getting rid of the undesirable ones.

One reason for ESG funds performing better in crisis periods and underperforming in non-crisis periods could be the prospect theory developed by Kahneman and Tversky in 1979. Under the theory, investors with the prospect theory elements are more negatively affected by losses than

positively affected by profits. Therefore, the utility gain for performing better in bear markets is larger than the loss in utility for underperforming in bull markets. In other words, investors are willing to underperform in bull markets if they perform better in bear markets, even if the total gain, in the end, is the same.

According to a survey made by Yankelovich Partners Inc, 80% of investors would not invest in the socially responsible fund unless the expected rate of return is more or the same as in a conventional fund. (Krumsiek 1997, 29) However, if the survey was made today, the results might differ. As mentioned in the USSIF (2020, 1-3) report, the assets under professional management that use SRI strategies have increased 42% from 2018 to 2020, indicating SRI funds' growth and increasing interest in socially responsible funds. This is an example of the massive growth in the demand for corporate social responsibility.

In a McKinsey & Company (2020) survey, most business leaders and investment professionals say that ESG factors create short-term and long-term value. Also, the amount of increase in value from each program has changed during the ten years in the survey. The respondents mention that one of the most critical parts of ESG performance is to comply with the regulations and industry expectations.

Figure 5 shows the share of respondents in the survey who say a given program of individual factors creates value long-term and short-term. The question was asked from respondents who say ESG programs create value in general. For example, in 2009, the most answered program for long-term value is environmental programs and governance programs for short-term value.

The share of respondents saying the ESG programs increase value has increased in every program during 2009-2019. However, relatively the most significant increase is in the social factor for both long-term and short-term.

Figure 5. Survey results (McKinsey & Company, 2020, 3)

Most of the executives and investment professionals in the survey say that ESG factors affect corporate performance. The respondents also answered how they believe ESG creates value in the survey. In 2009 and 2019, the most important ways ESG creates value are by maintaining a good brand and reputation and attracting and motivating talented employees. The most positive change from 2009 to 2019 is in strengthening organization’s competitive advantage. The most negative change is in improving operational efficiency or decreasing costs. The survey also shows a desire to improve the ESG data, metrics, standards, and reporting. Especially investment professionals want more standardized ESG data integrated into financial data that is readily benchmarked.

Edmans (2011) investigates the relationship between social factors through employee satisfaction and long-run stock returns. He finds that a value-weighted portfolio of the "100 Best Companies to Work for in America" has returned 2.1% above industry benchmarks during 1984-2009. The

“best” companies also were more prone to positive earnings surprises. He suggests that these positive surprises might be because social intangibles can be harder to quantify and measure.

Derwall, Koedijk, and Ter Horst (2011) find that companies with higher employee relations and community involvement earn abnormal returns compared to counterparts with worse corresponding features, which is in line with other studies. The abnormal returns apply only short-term, and the abnormal returns diminish in the long-term for socially responsible stocks. They

argue that the economic value in CSR practices is difficult to measure in the short-term, but in the long-term, investors should be able to include the CSR value in a company's fundamentals.

Baier, Berninger, and Kiesel (2020) analyze the words of environmental, social, and governance in annual reports. They find that governance and corporate governance are mentioned more often in annual reports than environmental or social. They argue that this can indicate that the focus is more on shareholders than other stakeholders. They point out that governance issues have been discussed to a more extent historically, but environmental and social have gained more attention during the last decade.